Section 116 relief for non-resident investors

Francesco Gucciardo and Richard E. Clark

Great news for non-resident investors, including, in particular, non-resident investors in private equity funds. The Canadian Federal Government has proposed a substantial change in its most recent budget (dated March 4, 2010) to the definition of "taxable Canadian property" (TCP) to exclude the shares of a corporation, interests in a partnership and interests in a trust that do not derive and have not derived at any particular time in the 60-month period that ends at the time of measurement (i.e., the time of disposition), directly or indirectly, their value principally from one or more of (i) real or immovable property situated in Canada, (ii) Canadian resource property, or (iii) timber resource property. As a consequence, this measure should eliminate section 116 compliance obligations (subject to a prospective purchaser's satisfaction that the subject property is not TCP), reduce the need for tax reporting and exempt a host of non-resident persons who would otherwise be taxable in Canada on the disposition of shares of Canadian corporations and other interests who do not currently qualify for exemptive relief under an existing Canadian income tax treaty or convention ("tax treaty").

TCP is currently defined to include shares of a corporation resident in Canada that are not listed on a designated stock exchange, significant interests in listed shares of a corporation resident in Canada, and other interests the value of which are, or were within the 60-month period ending at the relevant time, derived principally from real or immovable property (including Canadian resource property and timber resource property). Gains from dispositions of "taxable Canadian property", other than of taxable Canadian property that is real or immovable property or shares that derive their value principally from real or immovable property, are generally exempt from taxation in Canada under many tax treaties.

Generally, subject to relief under an applicable tax treaty, a non-resident of Canada is: (i) subject to tax in Canada on any income or capital gain realized on the disposition of "taxable Canadian property" (TCP), (ii) required to file an income tax return reporting the disposition, and (iii) subject to the notification and other compliance obligations contained in section 116 of the Income Tax Act (Canada) (unless the TCP is otherwise an "excluded property").

In very general terms, a buyer acquiring TCP from a non-resident (even in non-arm's length situations) is required to remit a portion of the purchase price (typically 25%, but in some cases 50%) to the Canada Revenue Agency (CRA) in respect of the non-resident vendor's Canadian tax liability unless (i) the non-resident vendor obtains a so-called "Section 116 clearance certificate" from the CRA in respect of the sale, (ii) the purchaser is satisfied that the particular property is an "excluded property" (e.g. a listed security or property any gain from the disposition of which would be exempt from tax in Canada under the terms of an applicable tax treaty), or (iii) in the case of a non-arm's length transfer of TCP, any gain from the disposition of which would be exempt from tax in Canada under the terms of an applicable tax treaty and the purchaser files a special notification containing certain required information that is certified to be true by both parties. In practice, a purchaser will ensure it has a contractual right to withhold the required amount from the purchase price otherwise payable to the non-resident vendor in order to satisfy its remittance obligation, if any.

In order to obtain a clearance certificate, a non-resident vendor must remit an amount to the CRA on account of the non-resident's potential tax liability, if any, or post security. Administratively, the CRA will generally issue a clearance certificate if is satisfied that no tax will ultimately be due from the non-resident vendor (e.g. treaty-exempt or no gain). In many circumstances, for example with multiple investors in private equity funds, obtaining such certificates can be very timing-consuming and expensive.

For further details on these and other changes announced in the Federal Government's budget please see the Stikeman Elliott commentary on the budget.

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